5.4 Use the Excel spreadsheet named “LeasevsBuyCCA” (link is on the Assignment 2

Question

5.4 Use the Excel spreadsheet named “LeasevsBuyCCA” (link is on the Assignment 2 page) to answer the following question. You may choose to answer the question without using the spreadsheet, but be very careful to show all work, so your marker can follow your calculation and award part marks as necessary.

You want to buy a new car, but you're not sure whether you should lease it or buy it. You can buy it for $50,000, and you expect that it will be worth $20,000 after you use it for 3 years. Alternatively, you could lease it for payments of $650 per month for the 3-year term, with the first payment due immediately. The lease company did not tell you what interest rate they're using to calculate the monthly payments, but you know you could borrow money from your banker at an annual percentage rate (APR) of 8%.

       A.   Calculate the present value of the lease payments, assuming monthly compounding at the given APR of 8%.

       B.   Calculate the present value of the $20,000 salvage value, again using monthly compounding and the given APR of 8%. Which option do you prefer, lease or buy?

       C.   Calculate the amount of the salvage value which would make you indifferent between leasing and buying.

D.   If you were able to use this car 100% for business, rendering the lease payments tax-deductible, or alternatively, allowing you to deduct depreciation, and assuming your tax rate is 40%, would you prefer to buy or lease the car?

Explanation / Answer

Year Monthly lease Discount rate Discout Factor Discounted cash flow 0.00 650.00 0.0% 0.000 650.00 1.00 650.00 0.7% 0.993 645.48 2.00 650.00 0.7% 0.986 641.19 3.00 650.00 0.7% 0.980 636.92 4.00 650.00 0.7% 0.973 632.68 5.00 650.00 0.7% 0.967 628.47 6.00 650.00 0.7% 0.960 624.29 7.00 650.00 0.7% 0.954 620.13 8.00 650.00 0.7% 0.948 616.00 9.00 650.00 0.7% 0.941 611.90 10.00 650.00 0.7% 0.935 607.83 11.00 650.00 0.7% 0.929 603.79 12.00 650.00 0.7% 0.923 599.77 13.00 650.00 0.7% 0.917 595.78 14.00 650.00 0.7% 0.910 591.81 15.00 650.00 0.7% 0.904 587.87 16.00 650.00 0.7% 0.898 583.96 17.00 650.00 0.7% 0.892 580.07 18.00 650.00 0.7% 0.886 576.21 19.00 650.00 0.7% 0.881 572.38 20.00 650.00 0.7% 0.875 568.57 21.00 650.00 0.7% 0.869 564.78 22.00 650.00 0.7% 0.863 561.03 23.00 650.00 0.7% 0.857 557.29 24.00 650.00 0.7% 0.852 553.58 25.00 650.00 0.7% 0.846 549.90 26.00 650.00 0.7% 0.840 546.24 27.00 650.00 0.7% 0.835 542.60 28.00 650.00 0.7% 0.829 538.99 29.00 650.00 0.7% 0.824 535.40 30.00 650.00 0.7% 0.818 531.84 31.00 650.00 0.7% 0.813 528.30 32.00 650.00 0.7% 0.807 524.79 33.00 650.00 0.7% 0.802 521.29 34.00 650.00 0.7% 0.797 517.82 35.00 650.00 0.7% 0.791 514.38 20863.33 Year Car Buy decision cash flow 0 Cost of Car 50000 3 salvage value 20000*.793832 15876.64482 Present Value Total 34123.36 Lease the Vechicle as present value is lower Salavge value which would make you indifferent between leasing and buying salvage value =(50000-20863).793832 =36705 Tax rate Lease Buy Annual Payment 650*12 7800 10000 Tax advantage 3120 4000 The above table shows the relative advantages the firm would enjoy for the different options. The tax advantage comes as a result of the tax deductibility of both depreciation and the lease payments. From the table, tax advantage is higher with the buy option

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